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Is Whole Foods Market About to Have an Identity Crisis?

Whole Foods Market (NASDAQ: WFM) continues to feel the pressure from competitors like The Fresh Market (NASDAQ: TFM) and Sprouts Farmers Market (NASDAQ: SFM) . After its stock soared 1,200%, not including dividends, from the beginning of 2009 to the end of 2013, Whole Foods Market's stock has tumbled nearly 30% year-to-date.

Is what is happening within the organic and all-natural retail industry just increased competition? Or are other variables in play? Is the recent success of newer entrants like The Fresh Market and Sprouts Farmers Market the rare case where the remake is better than the original?

Perhaps the biggest question of all is whether Whole Foods Market, in an effort to make changes, is about to have an identity crisis.

By Dwight Burdette, via Wikimedia Commons

Should Whole Foods Market's earnings continue to influence its competitors?In its most recent quarter , Whole Foods Market delivered record revenue that rose 10% to $3.3 billion. However, net income remained unchanged compared to the same quarter a year ago at $142 million. The worst news from the quarter came when the company reported comp-sales growth of 4.5%, a big drop from the 6.9% growth seen last year and far less than the 8%+ growth the company has delivered quarterly for years.

Net income has taken a hit recently from not just the decline in comp sales, but also as a result of squeezed margins as competitors enter the market segment.

The Fresh Market saw its revenue surge 17.6% to $431.0 million in its most recent quarter . Net income fell 24.9% to $16.6 million, though, as the company has had some temporary struggles in its new markets of Houston, Texas and Sacramento, California. Nevertheless, the company saw its comp sales up 2.5% due to both an increase in the number of transactions and the average transaction size.

The Fresh Market highlights significant expansion opportunity that is similar to Sprouts Farmers Market's situation. Credit: The Fresh Market

Sprouts Farmers Market had by far the best quarter among the three . Revenue shot up 26% to $722.6 million as net income soared 86% to $33.7 million. Comp sales were up 12.8%, marking 28 straight quarters of positive same-store sales growth for Sprouts Farmers Market.

Will Whole Foods Market have an identity crisis soon?Whole Foods Market is in unfamiliar territory. Instead of setting the standard, it is in a situation where it is now making changes to answer its competition. Market trends within the organic and all-natural retail industry have left Whole Foods Market scrambling to decide which issue to address first.

First, competition is coming in from all directions. Mainstream supermarkets have increased their own organic and natural food selections while big-box retailers have started to enter the space.

A recent study by Planet Retail predicts that the average store size across grocery formats is set to shrink to less than 24,000 square feet by 2018. Whole Foods Market has already shifted away from its standard 50,000-70,000 square feet stores toward much smaller designs in the past couple of years. The company began to test stores under 40,000 square feet for the first time in 2008 . Its most recently opened stores in Jackson, Mississippi; New Orleans, Louisiana; and London, England earlier this year have been 35,000, 26,000, and 22,000 square feet, respectively .

The big problem with smaller stores is that they go against Whole Foods Market's business model of providing the largest selection of natural and organic food among retailers. With smaller and smaller stores, how can it still maintain this huge selection?

Lastly, price wars may be the most challenging issue for Whole Foods Market over the long term. Even though The Fresh Market doesn't see itself as an organic, all-natural retailer and Sprouts Farmers Market aims to appeal to a much broader demographic than Whole Foods Market, both companies are seen as reasons for Whole Foods Market's recent struggles.

The Fresh Market focuses on frequent promotions which rotate around different sections of its stores to drive customer traffic.

Sprouts Farmers Market has gained attention recently for undercutting mainstream supermarkets by as much as 25% while doing the same to Whole Foods Market by nearly 13% . The company's most recent presentation highlighted the slogan "healthy living for less".

As a result, Whole Foods has already lowered its prices, albeit quietly to avoid any perceived decline in quality . When you add cannibalization and smaller stores into the mix, is Whole Foods Market the same company it was just a few years ago?

Can the U.S. handle over 3,000 organic and all-natural retailers?Whole Foods Market is expected to cross 400 stores by the end of 2014 and 500 stores by the end of 2017. Based on its most recent conference call, the company plans to hit 1,200 U.S. stores over the long term.

Sprouts Farmers Market believes 1,200 stores is a possibility in the next 15 years, while 1,500 stores aren't out of the question.

Even though The Farmers Market hasn't stated its long-term U.S. store count goals, the company should be past 200 stores by the end of next year given that its store count of 157 is supposed to expand by another 23 to 24 stores this year.

When you add it all up, are there enough organic and all-natural customers to make all three companies successful? More importantly, given the recent struggles of Whole Foods Market, how can it handle the inevitable expansion of this market in the future?

Bottom lineA new report from the consulting firm PwC argues that grocers can't rely on providing a one-size-fits-all consumer experience . Perhaps Whole Foods Market's best play right now is to be itself.

Changing too much too fast may wind up alienating customers. Even worse is that changing too many things at once may make it nearly impossible to see what works and what doesn't work. Are lower prices driving traffic or are the smaller stores pushing customers away due to their cramped aisles?

The biggest stat of all may be that the natural and organic U.S. industry, which has multiplied its sales by eight times from 1998 to 2012 with growth to $48 billion, has become a lot more fragmented and specialty retailers like Whole Foods Market have seen their slice of the pie on a percentage basis cut in half -- literally.

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John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Michael Carter has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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I graduated with honors with a B.S. in Mechanical Engineering from Virginia Tech and later got my MBA from the University of Pittsburgh. I'm a Licensed Professional Engineer (P.E.) for the state of Pennsylvania. As an experienced equities investor and Motley Fool member since 2006, I try to show that investing is not only for the pros. Follow @mikecart1